Provision for Credit Losses (PCL)

What Does Provision for Credit Losses Mean?

The provision for credit losses (PCL) is an assessment of potential losses that a company could experience due to credit risk. The provision for credit losses is treated as an expense on the company's financial statements. They are expected losses from delinquent and terrible debt or other credit that is probably going to default or become unrecoverable. On the off chance that, for instance, the company works out that accounts north of 90 days past due [have a recovery rate](/terrible debt-recovery) of 40%, it will make a provision for credit losses in light of 40% of the balance of these accounts.

Grasping Provision for Credit Losses (PCL)

Since accounts receivable (AR) is expected to go to cash in the span of one year or an operating cycle, it is reported as a current asset on a company's balance sheet. Be that as it may, since accounts receivable might be exaggerated on the off chance that a portion isn't collectible, the company's working capital and investors' equity might be exaggerated too.

To guard against overstatement, a business might estimate the amount of its accounts receivable will probably not be collected. The estimate is reported in a balance sheet contra asset account called provision for credit losses. Increments to the account are likewise kept in the income statement account uncollectible accounts expense.

Illustration of Provision for Credit Losses

Company An's AR has a debit balance of $100,000 on June 30. Roughly $2,000 is expected to not go to cash. Therefore, a credit balance of $2,000 is reported as a provision for credit losses. The accounting entry for adjusting the balance in the allowance account includes the income statement account uncollectible accounts expense.

Since June was Company A's most memorable month in business, its provision for credit losses account started the month with a zero balance. As of June 30, when it issues its most memorable balance sheet and income statement, its provision for credit losses will have a credit balance of $2,000.

Since the provision for credit losses is reporting a credit balance of $2,000, and AR is reporting a debit balance of $100,000, the balance sheet reports a net amount of $98,000. As the net amount will probably transform into cash, it is called the net realizable value of the AR.

Company An's uncollectible accounts expense reports credit losses of $2,000 on its June income statement. Even however none of the AR was due in June, the expense is reported since terms are net 30 days. Company An is endeavoring to follow the matching principle by matching the terrible debts expense to the accounting period in which the credit sales happened.